Small Business Deduction

The current Small Business Deduction in Canada allows corporations to pay a lower rate of tax on their first $500,000 of active business income. Active business income includes income earned from a company’s regular operations, but excludes other income such as rental or investment income.

Budget 2016 released by the federal government has introduced a number of changes to the Small Business Deduction, which could limit a corporation’s ability to take advantage of the associated tax savings. Two of the major changes that affect small business owners are as follows:

Corporations will not be able to claim the Small Business Deduction on any active business income earned from another corporation where there is common ownership.

Specified Corporate Income (SCI)

  • Specified Corporate Income is a new concept that represents payments made between corporations that do not deal at arm’s length and one corporation has ownership or an interest in the other.
  • Corporations will not be able to claim the Small Business Deduction on any active business income earned from another corporation where there is common ownership.
  • There is no ownership threshold. This means the rules will come into effect, even if your business only owns 1 share out of a million issued shares of the corporation providing the product or service.
  • An example is an operating company that pays management fees to its holding company. The holding company owns 100% of the shares in the operating company. The holding company is not eligible to claim the Small Business Deduction on management fees paid to them as these fees will be considered SCI.
  • If you have other activity that makes up 90% or more of your total income (from unrelated parties), the restricted Small Business Deduction will not apply.
  • For associated corporations, you can allocate a portion of your $500,000 limit to the other corporation, allowing them to take advantage of the lower rate.

 

Designated members of partnerships

Under Budget 2016, these designated members would not be able to access the Small Business Deduction limit because they are not a partner of the corporation

  • Under current tax rules if you are a corporate member of a partnership, you must share the $500,000 limit with your other partners.
  • As a result of this existing rule, many partnerships have used different structures including incorporating separate companies to conduct business with that partnership, in order to use the full $500,000 Small Business Deduction limit.
  • These companies are defined as ‘designated members’ of the partnership and include corporations that provide services or property to a partnership, shareholders that hold a direct or indirect interest in the partnership, but are not direct members of the partnership.
  • Under Budget 2016, these designated members would not be able to access the Small Business Deduction limit because they are not a partner of the corporation. They would not be able to claim the Small Business Deduction on income earned from the partnership.

 

If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.

Thanks to Stephanie Kwan of KWB Chartered Accountants for providing this content.

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